How Are Business Acquisitions Financed?

How Are Business Acquisitions Financed?

When buying or selling a business in Phoenix, it is important to know upfront how deals get financed so there are no surprises or false expectations.

Phoenix, AZ

Selling your business can be a hassle and a challenge, which is why the help of an experienced Phoenix Business Broker offers tremendous value. The process of finding a suitable buyer alone oftentimes takes much longer than the seller would like, but with persistence and by pursuing the right avenues, a buyer can usually be found.

However, it is not enough for your buyer to be interested in your business; they have to have the funds to acquire it. So where exactly is your buyer’s money coming from?

There are basically three ways business acquisitions are financed:

1. The buyer pays 100% cash.

In most cases the sellers I meet with want all cash for their business. And really who wouldn’t? If the interested buyer pays all cash, you won’t have to worry about him (or her) and your business qualifying for a loan. So cash is definitely the top choice of how sellers want to get paid. However, it has its drawbacks as well. What? How could that be? Remember the last time you bought a car and they offered you a discount (or you asked for one) if you’d pay cash? The same holds true for your potential buyer. See, the downside to this is buyers who pay all cash expect to get a big discount off of the sales price. As the saying goes, Cash is King and the buyers want to be compensated for that. And if you are honest, so would you. Cash reduces the seller’s risk and the buyer feels that this should be appropriately rewarded, with a discount. For obvious reasons, this is not the most common way deals get financed.

2. The seller will carry a note for part of the purchase price.

So if the full amount in cash is not available to the buyer or the seller is not in agreement with the buyer’s desired cash discount, there is another way the deal can be done. A seller carry note. This is the most common way deals get done.

A seller carry note is pretty much what it sounds like, the seller actually finances a part of the purchase price himself. This means the seller acts as the bank and “loans” a part of the purchase amount to the buyer. This of course requires checking out the buyer’s background, credit score, and financial position. It also requires a substantial down payment from the buyer.

While most sellers are initially apprehensive towards this type of financing, it can be very beneficial to all parties involved. Approximately 80% of business sales are financed this way. The benefit to the seller is that this course of action can attract more buyers, as buyers rarely have the entire sum available in cash, and the asking price usually won’t have to be lowered to accommodate an all cash payment. Some buyers won’t even look at a business that doesn’t offer some seller financing, because they take it as a sign that the seller has no confidence in the future prospects of their business.

Even if the buyer is working with some kind of small business administration loan (SBA loan), the bank generally prefers some type of seller financing, for the same reasons as already mentioned; it demonstrates that the seller believes in the future prospects of his business. Most buyers want to put the least amount of cash down on a business and sellers want as much cash as possible. When I handle a deal like this, I typically get the seller to put 50% cash down and have the buyer carry the balance in the form of a seller carry note. The term of the note is usually anywhere from 3-5 years with annual interest of 6-7% and payments made to the seller every month.

3. The buyer obtains an SBA loan.

While you may think this seems to be the most logical way to finance a business acquisition, it is not the case. An SBA backed loan is actually the most uncommon way to get a deal done because both the buyer and the business have to qualify. The bank will want the buyer to have good credit, at least 10-20% cash down, and 2-3 years of relevant industry experience in the business they are buying. This again limits the potential pool of buyers, as they essentially can only purchase businesses they have experience with. The business will need to have at least three years of financials and tax returns to prove the income. Lots of small business owners do not keep good books and records so this can be a deal killer.

Even if both parties opt and qualify for a SBA Loan, there are certain drawbacks. For one, there is a lot of paperwork involved, which can make the sale of your Phoenix business seem like it will take forever. Additionally, the criteria to get a loan are very strict and can mean that no additional loans by the buyer will be allowed in the future. For these reasons, this is the least common and way of financing a business purchase. An experienced Arizona business broker can assist you in determining the right course of action and what type of financing is best for your particular situation.

When buying or selling a business in Phoenix, it is important to know upfront how deals get financed so there are no surprises or false expectations. If you would like to discuss your own exit strategy and the possibility of selling your Phoenix business, contact me at 480-707-7721 or philreeseaz@gmail.com.

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